FRL-3000 Ch 14 Concepts

Which one of the following statements is correct for a firm that uses debt in its capital structure? A. The WACC should decrease as the firm's debt-equity ratio increases. B. When computing the WACC, the weight assigned to the preferred stock is based on the coupon rate multiplied by the par value of the preferred. C. The firm's WACC will decrease as the corporate tax rate decreases. D. The weight of the common stock used in the computation of the WACC is based on the number of shares outstanding multiplied by the book value per share. E. The WACC will remain constant unless a firm retires some of its debt.

A. The WACC should decrease as the firm's debt-equity ratio increases.

The dividend growth model: A. is only as reliable as the estimated rate of growth. B. can only be used if historical dividend information is available. C. considers the risk that future dividends may vary from their estimated values. D. applies only when a firm is currently paying dividends. E. uses beta to measure the systematic risk of a firm.

A. is only as reliable as the estimated rate of growth.

The capital structure weights used in computing the weighted average cost of capital: A. are based on the book values of total debt and total equity. B. are based on the market value of the firm's debt and equity securities. C. are computed using the book value of the long-term debt and the book value of equity. D. remain constant over time unless the firm issues new securities. E. are restricted to the firm's debt and common stock.

B. are based on the market value of the firm's debt and equity securities.

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called? A. dividend yield B. cost of equity C. capital gains yield D. cost of capital E. income return

B. cost of equity

The weighted average cost of capital for a firm is the: A. discount rate which the firm should apply to all of the projects it undertakes. B. rate of return a firm must earn on its existing assets to maintain the current value of its stock. C. coupon rate the firm should expect to pay on its next bond issue. D. minimum discount rate the firm should require on any new project. E. rate of return shareholders should expect to earn on their investment in this firm.

B. rate of return a firm must earn on its existing assets to maintain the current value of its stock.

The flotation cost for a firm is computed as: A. the arithmetic average of the flotation costs of both debt and equity. B. the weighted average of the flotation costs associated with each form of financing. C. the geometric average of the flotation costs associated with each form of financing. D. one-half of the flotation cost of debt plus one-half of the flotation cost of equity. E. a weighted average based on the book values of the firm's debt and equity.

B. the weighted average of the flotation costs associated with each form of financing.

Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is correct? A. The aftertax cost of debt will be greater than the current yield-to-maturity on the firm's bonds. B. The firm's cost of preferred is most likely less than the firm's actual cost of debt. C. The firm's cost of equity is unaffected by a change in the firm's tax rate. D. The cost of equity can only be estimated using the SML approach. E. The firm's weighted average cost of capital will remain constant as long as the capital structure remains constant.

C. The firm's cost of equity is unaffected by a change in the firm's tax rate.

Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure. A. This model considers a firm's rate of growth. B. The model applies only to non-dividend paying firms. C. The model is dependent upon a reliable estimate of the market risk premium. D. The model generally produces the same cost of equity as the dividend growth model. E. This approach generally produces a cost of equity that equals the firm's overall cost of capital.

C. The model is dependent upon a reliable estimate of the market risk premium.

The weighted average cost of capital for a wholesaler: A. is equivalent to the aftertax cost of the firm's liabilities. B. should be used as the required return when analyzing a potential acquisition of a retail outlet. C. is the return investors require on the total assets of the firm. D. remains constant when the debt-equity ratio changes. E. is unaffected by changes in corporate tax rates.

C. is the return investors require on the total assets of the firm.

Flotation costs for a levered firm should: A. be ignored when analyzing a project because they are not an actual project cost. B. be spread over the life of a project thereby reducing the cash flows for each year of the project. C. only be considered when two projects are mutually exclusive. D. be weighted and included in the initial cash flow. E. be totally ignored when internal equity funding is utilized.

D. be weighted and included in the initial cash flow.

Incorporating flotation costs into the analysis of a project will: A. cause the project to be improperly evaluated. B. increase the net present value of the project. C. increase the project's rate of return. D. increase the initial cash outflow of the project. E. have no effect on the present value of the project.

D. increase the initial cash outflow of the project.

If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to: I. reject some positive net present value projects. II. accept some negative net present value projects. III. favor high risk projects over low risk projects. IV. increase its overall level of risk over time. A. I and III only B. III and IV only C. I, II, and III only D. I, II, and IV only E. I, II, III, and IV

E. I, II, III, and IV

The weighted average cost of capital for a firm may be dependent upon the firm's: I. rate of growth. II. debt-equity ratio. III. preferred dividend payment. IV. retention ratio. A. I and III only B. II and IV only C. I, II, and IV only D. I, III, and IV only E. I, II, III, and IV

E. I, II, III, and IV

The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations? I. firms that have a 100 percent retention ratio II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend A. I and II only B. I and III only C. II and III only D. I, II, and III only E. II, III, and IV only

E. II, III, and IV only

Which of the following statements are correct? I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant. A. I and III only B. II and IV only C. III and IV only D. I, II, and III only E. II, III, and IV only

E. II, III, and IV only

When a firm has flotation costs equal to 7 percent of the funding need, project analysts should: A. increase the project's discount rate to offset these expenses by multiplying the firm's WACC by 1.07. B. increase the project's discount rate to offset these expenses by dividing the firm's WACC by (1 - 0.07). C. add 7 percent to the firm's WACC to get the discount rate for the project. D. increase the initial project cost by multiplying that cost by 1.07. E. increase the initial project cost by dividing that cost by (1 - 0.07).

E. increase the initial project cost by dividing that cost by (1 - 0.07).

The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the: A. reward to risk ratio. B. weighted capital gains rate. C. structured cost of capital. D. subjective cost of capital. E. weighted average cost of capital.

E. weighted average cost of capital.